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Big shots' self interest funds start-ups

More and more big vendors are investing in start-ups, often with their own prosperity in mind

February 19, 1999
Web posted at: 7:45 p.m. EST (0045 GMT)

by Bob Trott


(IDG) -- Like a rancher who grows corn to feed his own cattle, the biggest high-tech companies are funneling more and more seed money into small start-ups with the hope of cultivating the products they make and the standards they endorse.

The big shots -- including Novell, Oracle, Intel, and Microsoft -- make altruistic pronouncements about offering a helping hand to the small fries, remembering wistfully when they, too, were just a couple of folks working out of a garage. This help usually comes in the form of venture capital, but it can also include promotional support, development resources, discounted products, and even matching small companies with funders.

While this aid appears generous on the surface, the chief motivation is self interest; although the details may differ from program to program, the industry giants seem to have the same two goals in mind. One is to make money by investing in what they hope are promising companies that will pay off down the road. The other is the continuing spread of their own technologies and competitive allegiances: Microsoft backs Windows companies, Oracle eyes companies that will compete with Windows, Intel looks for products that push the need for faster chips, and Novell uses other companies to boost Novell Directory Services.

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Yet the synergy that comes with a big-little partnership is often mutually beneficial.

"The larger companies get to move into new spaces, gain rights to technology, and also make pretty good investments," says Rob Owens, an analyst at Pacific Crest Securities, in Portland, Ore. "The smaller ones get aligned with the bigger players early in the game. It also ensures that some standards are set so [start-ups] can move forward to new technologies."

According to figures from VentureOne, a San Francisco-based investment research company, total venture capital investing exceeded $12 billion in 1998.

"IT continues to dominate, and investments in Internet companies have risen significantly," says Jean Yaremchuk, VentureOne's research director.

One reason why large-company investments are on the rise is that as these companies eye broader areas of technology, the internal resources needed to drive development are shrinking. Companies that previously were content with a seat on a start-up's board now are setting up "pre-wired" deals, in which the possibility of an acquisition has already been hammered out, according to one venture capital company partner.

"The traditional model has been to fund a start-up to get a seat at the table to see whether it's going to be a strategic acquisition," says Susan Green, at OnSet Ventures, in Menlo Park. Calif. "The thing that's changed is that the guys at the table are often getting beat out of the acquisition. So they're not waiting anymore; they are cutting the deal right at the beginning."

What these deals mean to IT users is that the de facto standards offered by big companies are strengthened when more third-party companies support them. Additionally, companies that IT users might never have otherwise heard of are in the headlines, therefore expanding the number of products that might make it onto their purchasing radar.

"I think [some] partnerships and investments are of huge benefit," says Brian Jaffe, a New York-based IT consultant. "They should hopefully lead to more standardization, an increased likelihood that products will work together better, and who knows, maybe even improved quality."

Microsoft, one of the most aggressive vendors in this area, makes its investments very deliberately, according to Greg Stanger, senior director of business development and investments at the Redmond, Wash., software giant. Although the company says it has no dedicated venture capital fund, during the past four years Microsoft has spent a whopping $4 billion in 80 deals, investments, or outright acquisitions. These range from a couple of million dollars in a small company to Microsoft's biggest investment ever, a $1 billion stake in cable television operator Comcast in 1997.

"We are not saying, 'This company supports Microsoft platforms, so we are going to put money into them,' " Stanger says. "We say, 'Not only will we give you money, but we'll also have a preferred, strategic relationship that ideally is worth a whole lot more than the money.'"

Clearly Microsoft looks to help companies that will base products on its technologies, such as Windows. Likewise, Novell -- whose $50 million Internet Equity Fund has now invested in five start-ups -- has a single-minded focus: the proliferation of Novell Directory Services.

"When we look at the types of companies we want to invest in, the main question is, 'How will their company help Novell accelerate the growth of the directory?' " says Blake Modersitzki, director of strategic investments at Novell, in Provo, Utah.

Intel has a similar strategy: Whether the chip giant takes a small equity position in a company or makes a strategic investment, the commitment is designed to get specific results. Intel created the Corporate Business Development Group to oversee equity, or what executives call "strategic" investments, and in the past five years has invested some $1 billion in smaller companies.

"Some [investing] companies are looking for a return on investment, but we are looking to grow market segments," says Michael Sullivan, an Intel spokesman, in Santa Clara, Calif.

Intel does not make any bones about the fact that growing the market segments in which the company is involved is not a charitable endeavor. Indeed, the chip giant in January announced two major investments in the memory divisions of Micron Technology and Samsung, with the goal of ramping up the time to market of Direct Rambus DRAM technology.

"We are developing fast processors, and we don't want memory to be a barrier," Sullivan says. "It is strategic to Intel."

Novell walks a fine line between largess and opportunism in its investments, Modersitzki says.

"We try not to limit the dedication of the company [in which we have invested]," Modersitzki says. "But if we are to invest, we want the company to make a commitment to Novell. It does not make sense for me to invest in a company that is not going to invest in Novell technology."

Redwood Shores, Calif.,-based Oracle waded into the venture capital arena in a big way in January, unveiling the $100 million Oracle Venture Fund.

Dave Roux, a member of the Oracle Venture Fund's investment committee, acknowledges that Oracle "has not been the easiest company for small companies to deal with," a situation the Fund will seek to correct.

As with Microsoft, gaining mind share is a key consideration for Oracle.

"Oracle now wants to be in from the beginning with these companies when they are making their initial design decision," Roux says. "There's nothing unique about our cash, but we can help in how we play with [small companies]. We can deliver market visibility, public relations, trade shows, international reach, and access to our customer base."

With so many of its competitors now taking part in the seed money game, Microsoft has made steps to differentiate itself to the small developer that may be in need of guidance. In September 1997, Microsoft established the Developer Relations Group, which is not directly related to its investments group, but capable of offering a synergy with start-ups that many rivals -- including IBM and Novell -- have contemplated copying.

Microsoft to date has signed 1,700 companies to work with the Developer Relations Group. The criteria: The start-up must have less than 40 employees, be less than 4 years old, and have on the shelves or in beta testing a product that leverages Microsoft technologies.

"This is not business development and investments, but we accomplish that via co-marketing opportunities," says Kristen McGuire, marketing manager for Microsoft's start-up and venture capital relations group.

Microsoft's start-up partners in this program receive substantial discounts on Microsoft tools and conferences. The smaller companies also benefit from information and resources, such as a Web site designed to inform venture capital companies of what these companies are doing.

"If [a venture capital group] wants someone working with Windows CE in California, we have a matchmaking program as well," McGuire says.

The small companies also get marketing and promotions help, including exposure at trade shows sponsored by Microsoft and others. At Comdex in November 1998, for example, eight start-ups were featured at a pavilion within the boundaries of Microsoft's show-floor real estate.

One start-up featured by Microsoft at Comdex was MediaTruck, a 14-month-old, eight-employee company in Austin, Texas that hopes this spring to release its r.e.d.d. (Rapid Episode Development and Delivery) System, a Web development tool designed for nonprogrammers.

"It's very appealing when it starts out as two guys in a garage," says Paul Pugh, president and CEO of MediaTruck. "[Microsoft] helped validate what we do."

According to Pugh, Microsoft does not dictate what MediaTruck does. However, the bigger company definitely watches after its own interests.

"They review what we are saying; it's important to them to see that we are tying together their new technologies," Pugh says. "I wouldn't say they would exclude us if we were using new technologies, or something like Java. They don't go byte by byte saying, `You could have used this thing here instead.'"

Part of what spurs Microsoft to help the start-ups is its keen awareness of the attention garnered by competing technologies, particularly Sun Microsystems' Java.

"If you had a Java company, they get funded very quickly, those hot companies out of [Silicon] Valley," Pugh says. "It's important for Microsoft to get the message out that these [Windows-based] companies are here, too."

Indeed, working to fuel the Java message is the $100 million Java Fund, run by financial company Kleiner Perkins Caufield & Byers (KPCB) and designed to help entrepreneurial ventures developing Java-based products that are targeted at new markets. The largest portion of the Java Fund is committed from KPCB's institutional limited partners, which include 20 university endowments and foundations such as Harvard, Stanford, the Massachusetts Institute of Technology, Duke, and Yale.

Acting as co-minority investors and limited partners in the fund are corporate partners including Sun, Cisco Systems, Comcast, Compaq, IBM, Itochu, Netscape, Oracle, TCI, and US West Media Group. KPCB makes its expectations for the Java Fund, which is currently involved with 17 companies, clear: excellent financial returns.

Yet not all industry bigwigs are sold on the idea of pumping cash into start-ups. IBM, for example, in recent years has shied away from funding beginners in favor of acquiring more established companies, such as Lotus and Tivoli, says John Bukovinski, an IBM spokesman, in Armonk, N.Y.

"Not by design, but by experience, IBM has had very little to do with IPOs [initial public offerings] and funding start-ups," Bukovinski says. "We did more in the past, but we found that they really don't pay big dividends. Big companies aren't necessarily good incubators."

3-D Software start-up benefits from Microsoft's nurturing

How iDream Software and Microsoft hooked up is a typical start-up-meets-behemoth story -- both had something the other wanted.

For the 3-year-old iDream, a 15-person maker of graphics software, Microsoft could provide entry into the crowded high-tech market by helping the company get its name out there and perhaps securing financial backing.

Microsoft, meanwhile, was looking to take its own graphics technology into the enterprise and was intrigued by iDream's Realism 3D, software designed to make it easier for users to create rich multimedia effects.

The result is that iDream became part of Microsoft's ISV start-up program, run by the company's Developer Relations Group. Through this program, many small companies secure financial support either through contacts facilitated by Microsoft or occasionally from the company itself.

"In order to evaluate your [venture capital] potential you have to have a lot of validation from a lot of internal organizations within Microsoft saying, `This is an important thing for us strategically,'" says Steve Petrucci, founder and chief technology officer of iDream, in Bothell, Wash. "Our access to people at Microsoft is good, and to other people of strategic importance outside Microsoft."

One notable benefit that iDream has reaped as part of Microsoft's program is exposure. The company had been involved in the program for only a couple of months when Microsoft offered iDream some prime real estate at fall Comdex in November 1998. This put iDream in the middle of the Microsoft traffic at the show, as opposed to being tucked away in the company's crowded Partner Pavilion.

"Having representation at some key events is really important, and in order to get a key presence it really requires a certain amount of consensus from Microsoft for what you are doing relative to their product strategies," Petrucci says. "We worked out because with [Microsoft's] DirectX and Chromeffects, they are trying to allow new capabilities and visualization techniques in business environments."

Since releasing Realism 3D -- the product that attracted Microsoft to iDream -- in a beta version, the small developer has begun working on another product, called Jio. Although it is Windows-based, this front-end Web tool features a Java applet to create effects such as the "paper doll" technology that is used on retailer Eddie Bauer's Web site.

Officials at Microsoft, who are not exactly the most Java-friendly people in the industry, did not raise an eyebrow when iDream told them about using Java, according to Petrucci.

"It's hard to find technology that encompasses all browsers," Petrucci says. "Java could do that. Version 1.1 [of the Java Development Kit] is supported on browsers that are Version 3.0 and above on a PC. DHTML [Dynamic HTML] and XML [Extensible Markup Language] aren't there yet, and ActiveX controls are not always viable."

Bob Trott covers Microsoft's products and strategies from InfoWorld's Seattle office. Ted Smalley Bowen, Jessica Davis, Ephraim Schwartz, David Pendery, Dana Gardner, and Michael Vizard contributed to this article.

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